Answer:
The two key factors that significantly affect Weighted Average Cost of Capital (WACC) are:
1. Cost of Debt.
2. Cost of equity.
Step-by-step explanation:
1. Cost of Debt: The cost of debt is a crucial factor in determining WACC, as it represents the interest expense a company incurs on its debt obligations. Two factors that affect the cost of debt are:
a) Interest rates: Changes in interest rates impact the cost of borrowing. When interest rates rise, the cost of debt increases, resulting in a higher WACC. Conversely, lower interest rates reduce the cost of debt and lower the WACC.
b) Creditworthiness: The creditworthiness of a company affects the interest rate it can obtain on its debt. Companies with higher credit ratings are considered less risky by lenders, resulting in lower interest rates and a lower WACC. Conversely, lower credit ratings lead to higher borrowing costs and a higher WACC.
2. Cost of Equity: The cost of equity represents the return required by investors to invest in a company's equity. Two factors influencing the cost of equity are:
a) Risk-free rate: The risk-free rate, typically based on government bond yields, serves as a baseline for determining the cost of equity. When the risk-free rate increases, the cost of equity also rises, resulting in a higher WACC.
b) Equity risk premium: The equity risk premium reflects the additional return demanded by investors for bearing the risk of investing in equities over risk-free assets. Changes in market conditions, economic outlook, or investor sentiment can influence the equity risk premium, impacting the cost of equity and subsequently the WACC.